Maybe Everyone Wanted to Be Fooled by Theranos

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In this "What's Up, Alison?" segment from Motley Fool Answers -- why, yes, you're right, they are switching it up this week -- Robert Brokamp and Alison Southwick consider the rise and fall of blood-testing company Theranos, and its charismatic CEO and founder, Elizabeth Holmes. She is accused of conning investors out of hundreds of millions of dollars by promoting technology her company simply didn't have, and her success in that effort reveals a lot about the culture of the tech world, and why the people who should be looking out for such deceptions may not be. They also talk about warning signs that in retrospect seem fairly clear, and how Foolish investors might want to apply the lessons learned this time around to their future investments in -- what they hope will be -- cutting-edge technologies.

A full transcript follows the video.

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This video was recorded on March 20, 2018.

Robert Brokamp: So, what's up, Alison?

Alison Southwick: Yeah, that's right. It's What's Up Alison, not What's Up Bro this week. We switched it up on you guys. So, what's up with me is that I've been thinking about how glad I am that we no longer live in a world of medical quackery, where someone can claim a technological breakthrough and then investors sink a ton of money into that. But then it turns out the inventor was lying the whole time. I mean, just outright lying!

Brokamp: That doesn't happen anymore?

Southwick: Recently the SEC charged Theranos CEO and founder Elizabeth Holmes, and her COO, with perpetrating an elaborate fraud to deceive investors into believing that their portable blood analyzer could conduct comprehensive blood tests from a single drop of blood. Normally these kinds of tests require vial after vial, and they have to be sent out, and they come back. It's very labor-intensive and time-intensive.

They said, "Oh, we've got a solution." They start Edison, which they later named the miniLab. Well, it turns out it wasn't true. The SEC says she deceived investors out of $700 million between 2013 and 2015.

We now know, of course, that they were lying, and it flat out didn't work, but investors and the media were being lied to constantly by the founder. Theranos faked demonstrations. They lied about clinical trials. Lied about military contracts. They told investors they would make $100 million in a year when they ended up making $100,000. She told investors they didn't need FDA approval because they were the "gold standard." Talk about lying!

So, how did this happen and how can you avoid a similar trap as an investor? I have three takeaways.

Brokamp: Well, what are they?

Southwick: The first takeaway is to blame the media, particularly the tech media. Elizabeth Holmes was a great story. She didn't look like your typical entrepreneur. She was young [just 19 years old] when she founded the company. She was quite striking in her black turtlenecks, red lipstick, and blonde hair.

On the one hand, I feel kind of bad about describing her and objectifying her as a woman and being like, "Oh, she was a beautiful woman in science," but I really think it was part of the story...

Brokamp: I think it was, too. I agree with you.

Southwick: ... and why it was so remarkable. And she contributed to that very cultivated image, as well. Unfortunately, in America, of course, we don't associate beautiful with nerd, so the idea that she could be attractive to reporters was a great story. She was on the cover of Fortune, Forbes, Inc. -- you name it -- and she was touted as the next Steve Jobs. Forbes said she was worth $4.5 billion. Of course, this was all on paper.

But something that I thought was even more interesting about this -- rather than the media just loving her -- was Nick Bilton, who at Vanity Fair gave us a glimpse into how the world of Silicon Valley and tech writers worked. I never had a clue. Here's a quote from an article he wrote.

"After all, while Silicon Valley is responsible for some truly astounding companies, its business dealings can also replicate one big confidence game in which entrepreneurs, venture capitalists, and the tech media pretend to vet one another while, in reality, they are functioning as cogs in a machine that is designed to not question anything and buoy one another all along the way. In the end, it isn't in anyone's interest to call it BS."

Brokamp: Right, because if you're that person who's constantly challenging things, you're not the person who's going to get the interviews and get the access.

Southwick: The access, right. It's all about the access. It becomes a cycle of hype where entrepreneurs want more money, Silicon investors want to make money off what they're investing in, and tech reporters want a good story and they want to get access to people like Elizabeth Holmes.

And she knew how to work the media as long as they weren't medical experts. One of the big reasons why I think this was able to happen was because she was a medical tech company. Tech companies and tech writers that were writing about her didn't really understand the medical technology.

But healthcare reporter John Carreyrou at The Wall Street Journal [two-time Pulitzer Prize winner] was skeptical for a number of reasons, but one of the big ones was that she just couldn't explain how it all worked. For example, when The New Yorker asked her how this amazing technology works, she said, "A chemistry is performed so that a chemical reaction occurs and generates a signal from the chemical interaction with the sample, which is translated into a result, which is then reviewed by certified laboratory personnel." And then she added, "Thanks to miniaturization and automation, we are able to handle these tiny samples." And so, tech reporters were like, "Cool! Sounds good."

Brokamp: I bet there's some synergy in there, too.

Southwick: There's some synergy. There's some out-of-the-box thinking. It's so exciting.

Rick Engdahl: It really sounds like a cartoon villain.

Southwick: It does. Miniaturization and automation? That could go wrong. So, you can imagine. You're a two-time Pulitzer Prize winning reporter at The Wall Street Journal, John Carreyrou. You hear this and you're like, "Wait a second!"

So, the lesson that I have, here, is that instead of listening to the hype, you should listen to what the most qualified people are saying. In this case it was the writer at The Wall Street Journal and others who wrote story after story about how he was skeptical of Theranos. Meanwhile, others were singing her praises and still putting her on the covers of magazines.

Lesson No. 2. The company was secretive -- very secretive. As the saying goes, "Two people can keep a secret if one of them is dead," and Holmes was always very...

Brokamp: Killing people?

Southwick: We don't know that for sure. Holmes was always very secretive about how the technology worked. She said that she didn't want to tip off the competitors and people were like, "OK, cool." But now we know why she was so secretive about the technology.

This is kind of crazy. When she raised money, she took it from VCs on the condition that she would not divulge to investors how the technology works, and she would have final say and control over all aspects of the company. It scared off investors like Google Ventures, because they were like, "Hey, tell us about your company before we invest," and she was like, "No."

They sent a VC to one of these Walgreens Theranos labs where you go to get your blood drawn [supposedly the whole thing she was selling]. The VC is there having his or her blood drawn and noticed, "Huh, that's more than a pinprick of blood they're taking, here. Something doesn't add up." That's why Google Ventures didn't invest in it.

People tended to shrug off her secrecy as just another thing that she borrowed from Steve Jobs [her turtlenecks, her work ethic, and drinking green juice all day all long]. Here's another thing that she did that's so super sneaky and smart. When she assembled her board of directors, she chose a dozen older white men almost none of whom had a background in healthcare. It included former Secretaries of State, like Henry Kissinger. Former Defense Secretaries. Someone told Vanity Fair, "This was a board that was better suited to decide if America should invade Iraq than vet a blood-testing company."

How great is that? She's the only woman on this board. Charming. Young. She hires all of these very intelligent men, accomplished in their own fields, and just charms the pants off them [not literally that I know of. I did not mean to say that. That was not planned].

Fun fact: Her board also included the lawyer who tried to stop the revelations of Harvey Weinstein's sexual harassment for decades.

Pro tip: If that lawyer is involved in a company you're investing in, I would call that a sell sign. The company also internally was very siloed. Employees were discouraged from talking to each other about what they were working on and every decision crossed her desk according to Vanity Fair.

The lesson is some level of secrecy is to be expected, but a patsy within an organization is going to stifle collaboration. As a best-case scenario, as a worst-case scenario it's hiding something. Some shenanigans.

The final lesson is that we all wanted to believe; none of us more than Holmes. What did Theranos promise to do? Two hundred forty tests ranging from cholesterol to cancer with a finger prick of blood. Less blood, cheaper cost. It was just amazing. It was like a mission.

It was going to make the world a better place, which apparently is catnip to Silicon Valley investors who want to look like good dudes as opposed to just greedily trying to make money like the rest of us. They all wanted to believe in it, none more than Holmes, though. From the very beginning people told her this wasn't possible. Her idea of running all these tests from a single finger prick of blood was not going to work, but she kept at it, and I believe that she still thinks that she can do this.

She is still speaking at events. She's ditched her turtleneck, by the way, and talking to reporters about the technology that she has made, even though everybody knows it doesn't work. Her tenacity, audacity, and her ability to compartmentalize is quite impressive and it's because of this that I wouldn't be surprised if in like 10 years' time she comes out of hiding and is, "Actually, I did it. I finally cracked it. I've been working on it. I finally did it this time." And I wouldn't be surprised if people invested money in her again, because she is that tenacious.

Brokamp: What actually happened in the news? The SEC is going after them. Is she personally in legal trouble?

Southwick: It was her and her COO. She has settled with the SEC. She has to pay like $500,000 and she has to give back some shares of the company. You could set them on fire at this point. The big news is the SEC. She's also being sued by Walgreens because of those deals. She was literally lying to everyone at all times.

I went back and read some old articles. She said, "No, I don't wear this black turtleneck because of Steve Jobs. I wear it because when I was a kid, my mom saw Sharon Stone at the Academy Awards wearing a turtleneck, and from that point forward she had me and my brother wear turtlenecks a lot." I was like, "You're lying! That's the dumbest thing I've ever heard. You are absolutely wearing a stupid black turtleneck every day to look like Steve Jobs. It invokes Steve Jobs."

Brokamp: And they had to keep the temperature low...

Southwick: Sixty degrees.

Brokamp: ... so she would be comfortable in the turtleneck.

Southwick: Which is awesome. The lesson, here, is that if something seems too good to be true, let's assume that they're lying. I know most of us want to assume that we have these amazing technological breakthroughs, and we do. A lot of great entrepreneurs and inventors are out there doing fantastic things, but let's just assume they're lying, first, and then best-case scenario you're pleasantly surprised. Because the length that people are able to go to, to deceive us is just mind-boggling. She was lying to everyone all the time.

Brokamp: It's like a whole other risk to investing. When you buy a stock, you have to put so much trust in what you're being told, and the more complicated an investment is, the more you just have to assume that the company knows what it's doing, because you're not going to go, "I own Intuitive Surgical. I don't know anything about their robots. I just assume that they work, and they make enough money to prove it." But you're still putting a lot of faith in that.

Southwick: I think she was able to get away with a lot because it was still a private company, so she didn't have to do a lot of the standard filings that you have to when you go public. She was going to get found out, anyway. It was just a matter of time. I think she felt like she was always on the cusp of getting there, and really wanted to believe until it came true. It just never came true.

Engdahl: Alison, you're giving her a lot of credit for actually having a technology of some kind. For her to think that she's almost breaking whatever.

Brokamp: You'd think she'd have to.

Engdahl: Is there actually a technology?

Southwick: There's a little black box.

Engdahl: But there's a real miniaturizer in there? That's how I lose my weight. I go into there.

Southwick: There is a black box [the Edison], and then they renamed it.

Engdahl: It's literally a black box?

Brokamp: It is.

Southwick: It's literally a little black box.

Engdahl: There's nothing inside of it.

Southwick: They did get approved for testing for herpes. They did get approved for some tests, but this claim that you could look for 240 different conditions out of one drop of blood is just too audacious. It's going to take vials and vials, and massive big machines to do everything she claimed it could do. It could do something.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Alison Southwick has no position in any of the stocks mentioned. Rick Engdahl owns shares of GOOGL and GOOG. Robert Brokamp, CFP owns shares of ISRG. The Motley Fool owns shares of and recommends GOOGL, GOOG, and ISRG. The Motley Fool has a disclosure policy.